Expects inflation, credit growth to ease in coming months
By Chandeepa Wettasinghe
The Central Bank of Sri Lanka yesterday decided to keep its monetary policy stance unchanged during the seventh monetary policy review for 2017, with hopes that the higher than expected inflation and credit growth will moderate in the coming months.
Central Bank Governor Dr. Indrajit Coomaraswamy provided the same arguments made during the previous two monetary policy reviews as the basis for not changing the policy rates.
“At the start of the year we anticipated two peaks in inflation during the course of the year. One around March, and we saw the peak, and it came off, and we anticipated another peak around this time of the year, but the rate of inflation particularly, the headline inflation is higher than we anticipated,” he said.
Addressing the media yesterday, he said that although headline inflation—which includes products and services with volatile price movements—was high at 8.6 percent on the National Consumer Price Index this September, the core inflation, which the Central Bank is more concerned with as it reflects a more accurate picture of demand pressure in the economy, was at a lower 4.6 percent.
The Colombo Consumer Price Index too showed a similar trend in October. The Central Bank chose to keep the key monetary policy tools; the Standing Deposit Facility Rate at 7.25 percent, the Standing Lending Facility Rate at 8.75 percent and the Statutory Reserve Ratio at 7.50 percent.
The last instance the policy rates were adjusted was in March 2017, when the rates were increased by 25 basis points to curb inflation. The Central Bank is moving towards an inflation targeting monetary policy framework, and the International Monetary Fund (IMF), twice in recent months, advised the Central Bank to raise rates if inflation remains above expected levels. The Central Bank is working to improve its forecasting capabilities to move towards an inflation targeting framework.
Dr. Coomaraswamy said that inflation so far has been driven by the Value Added Tax (VAT) adjustment and the weather-related shocks, particularly in agriculture, both beyond the control of the Central Bank.
“In November, the base effect of VAT will wear out, which will exert some downward pressure on inflation. Also, if the agricultural production recovers—we are getting rains now—and hopefully it will, then some of the supply side issues will get addressed. In addition, in the budget, you will see some relief, as far as the cost of living is concerned,” he said.
“So if you take all this together, our view is that the rate of inflation will come back to within the range of 4-6 percent in the first quarter of next year,” he said.
However, he reminded of the need to remain vigilant, to ensure the headline inflation doesn’t convert to inflation expectations—so far unseen—and cause pressure for wage increases. On monetary expansion, broad money supply (M2b) increased 20.3 percent this September to Rs. 6.13 billion contributed by a build up of net foreign assets of both the Central Bank and commercial banks, with net foreign assets turning positive in September. There was increased rupee liquidity in the domestic market.
Net credit to the government on a year-on-year (YoY) basis fell to 14.1 percent in September compared to 15.8 percent in August. Private credit growth continued to fall down, at 17.5 percent in October, compared to 18 percent in September, although the absolute value of private credit extended was at Rs. 4.66 billion. “Credit growth peaked at about 28 percent the middle of last year, and since then it has been coming down, but it has been sticky downwards. We can see that. We would like to get it down to about 15-16 percent by the end of the year,” Dr. Coomaraswamy said.
He noted that although credit growth is high in the private sector, this credit is not going towards the usual suspects consumption and construction, which still claimed around 30-40 percent of credit.
“But there hasn’t been a pickup in investment as one would have hoped,” he said, however, speculating that investments may be on hold until investors see the direction of the budget with relation to the government’s announced policy package in the Vision 2025 document, and more stable macroeconomic conditions.
Dr. Coomaraswamy said that with hopes of continued growth in industry and services sectors over the last half of this year and with the recovery in the agriculture sector, economic growth would be ‘between 4-4.5 percent. Probably higher than 4 percent. I don’t know whether we will quite make it to 4.5 percent’. This expected recovery during the latter months, combined with an expected strengthening in the global economy according to the IMF, also contributed to keeping the rates unchanged, the Central Bank said. By the end of October, the rupee has depreciated by 2.5 percent against the dollar, while the country’s foreign reserves stood at US$ 7.5 billion.
Meanwhile, Dr. Coomaraswamy said that although maintaining interest rates competitive with relation to the US Fed rate will become a challenge in the future, the December Fed rate hike has been baked into the local rates.
Fiscal discipline in 2018 budget
Dr. Coomaraswamy is confident that the government will maintain fiscal discipline in the 2018 budget despite the crucial Local Government election coming up next January.
“We would be hoping that this positive trend we have seen in terms of fiscal management will continue, and I’m hopeful, I’m pretty confident that it will,” he said in response to a query on whether the upcoming elections will result in the budget providing consumption boosting proposals.
Successive governments have provided populist, consumption boosting proposals in budgets ahead of crucial elections, in order to buy votes. This has resulted in challenges for the monetary policy.
Price cuts on goods and services were in the past combined with keeping the exchange rate on the import-driven economy fixed until the end of an election, following which, consumers bear a shock, as the economy corrects itself after the politicians let go of the artificial holds which created favourable, short-term living conditions.
Dr. Coomaraswamy said that the fiscal performance has been good so far.
“There has been good fiscal performance since about April last year. If fiscal discipline slips, life becomes much more difficult for the Central Bank in terms of monetary policy formulation,” he said of the importance to continue fiscal consolidation in the 2018 budget.
